Tuesday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today our headlines feature new and improved price targets for blue chips UPS (NYSE: UPS) and Verizon (NYSE: VZ) . But before we get to the good news, let's take a quick look at why...

Echoing Merrill's fears that growth projections for Triumph Group are inflated, RBC Capital announced today that it's cutting the company's stock to underperform -- the Wall Street equivalent of "sell". Needless to say, this is a worrisome development.

Why? Priced at just 17.6 times earnings, Triumph Group shares already look overpriced based on consensus expectations that earnings will grow at less than 4% annually over the next five years. Obviously, 4% is not a lot of growth. And if Merrill and RBC are right about even this low number being "overly optimistic," then the $297 million that Triumph earned in fiscal 2013 could actually have been the stock's earnings peak -- with nothing but declines from here on out.

Indeed, Triumph's cash flow statement appears to forecast such declines, suggesting the company $206 million in profit last year (already down from fiscal 2013) is likely to be succeeded by further declines. After an extended period of strong free cash flow at the company,Triumph last year burned through more than $70 million in negative free cash flow, according to S&P Capital IQ data. If generally accepted accounting principles earnings follow this trend, as I think they must, then profits will fall, and Triumph Group's P/E will rise to show how truly expensive the stock is. The time to sell, as the analysts pointed out, is before this fact becomes obvious to everyone... i.e., now.

UPS going up?Turning to happier news, Briefing.com is reporting a new price target installed on buy-rated UPS by Argus Research. With shares up 18% over the past year, and priced at $103 today, Argus sees the stock rising to $115 per share over the course of the year. Combined with UPS' generous 2.6% dividend yield, this suggests there's more than 14% profit potential in the stock, which should be plenty to attract an investor's interest. But is Argus right?

I'm not convinced. Here's why: Priced at 22.8 times earnings today, UPS looks pretty expensive on its face. Free cash flow is strong, however -- $5.9 billion generated over the past year, versus reported net income of only $4.2 billion. That works out to a price-to-free cash flow ratio of about 16.

It's not an exorbitant price to pay. But given that most analysts see UPS growing earnings at only about 11.1% annually over the next five years, the total return ratio on this stock still works out to less than 14% (11.1% earnings growth, plus the 2.6% dividend yield). My feeling is that 16 times free cash flow may be too much to pay for such a return.

Granted, there's still the "buy a great stock at a good price" argument in UPS' favor. As one half of a globe-dominating parcel delivery duopoly, UPS has one of the widest business moats around, and the stock is at little risk of going away anytime soon. I just wish Argus had waited for a better price before urging investors to buy -- and I'd urge you to wait for one, too.

Initiating coverage of Verizon with a buy rating today, BTIG stated that "the migration to smartphones and resulting lift to ARPU that has benefited US telecom companies for the past eight years is coming to an end, further increasing the challenge to grow revenue and earnings." This is bad news for Verizon, but worse news for archrival AT&T (NYSE: T) , which BTIG thinks faces a risk of "revenue contraction" and "no growth" earnings going forward. In contrast, BTIG sees Verizon as a sort of safe haven, having "positioned itself well to sustain some level of revenue growth and deliver EPS in excess of consensus estimates" even in an era in which everyone already has a smartphone.

Is BTIG right? Let's look at the numbers. At less than 11 times earnings today, Verizon shares hardly look expensive on the surface. Moreover, with $21.3 billion in trailing free cash flow, this company is arguably much more profitable than its $13.5 billion in reported GAAP profits make it look.

What finally convinces me that BTIG is wrong about Verizon, though, is the debt. With the company carrying $105 billion more debt than cash on its balance sheet, debt is a big consideration for Verizon investors. It's the reason that while some people look at Verizon and see a stock trading for less than a P/E of 10, I look at Verizon and see a business selling for an enterprise value-to-free cash flow ratio of 14.5.

Simply put, 14.5 times free cash flow is too much to pay for a business expected to grow at only 6% annually over the next five years. Even if AT&T is a worse business, as BTIG argued, that only makes Verizon a better business by comparison. It doesn't make Verizon a good business, and it doesn't make it a buy.

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